The introduction of measures to encourage long-term thinking among investors and companies has been a distinctly long-term process. While evidence exists that those with a long investment horizon reap the rewards, market practitioners are uncertain about the impact of the Kay report on decision-making.

In a government-sponsored report in 2012, professor John Kay sought to encourage more responsible behaviour, by arguing his approach would improve long-term returns.

In the report, entitled “The Kay Review of UK Equity Markets and Long-Term Decision Making”, he said: “The shorter the timescale for judging manager performance and the slower market prices are to respond to changes in the fundamental view of securities, the greater the temptation to focus on the behaviour of other market participants rather than understanding the underlying value of the business.”

Relevance

At a stroke, Kay made stewardship relevant to investors who fail to think of the long-term consequences of their actions.

As Roger Urwin, global head of investment content at Towers Watson, said: “John Kay’s report gets many honourable mentions globally even though it only had a UK remit. In that sense, it captured the new zeitgeist that short-termism is a real problem requiring serious attention.”

But he added: “Solutions to long-termism are of course way harder – because of our deep-seated cognitive desires for the quick and the simple.”

Late last year, the Investment Management Association took the first steps towards finding a solution. It revealed plans to establish an investor forum to make long-term investment a focus of stewardship activity.

The IMA implementation team is led by Sacha Sadan, director of corporate governance at Legal & General.
Daniel Godfrey, chief executive of the IMA, agrees long-term leadership can have competitive advantages.

He is keen to see quarterly reporting by companies scrapped, although only a limited number of listed companies have made decisive moves in this direction. Unilever, for example, decided in 2011 to no longer report short-term profits and earnings on a quarterly basis.

Kay also recommended the Law Commission consult with the industry on the legal concept of “fiduciary duty” and how to align the interests of investors and their agents. The commission’s report is due out in June. Policymakers, industry groups and politicians face an uphill struggle to implement change because of the entrenched behaviour of market participants. For example, the parliamentary Business, Innovation and
Skills Committee report published in October last year noted that the 2001 Myners Report on institutional investment failed to substantially change behaviour.

It said: “We agree the industry should be given a chance to change of its own volition but the experience of the Myners Report does not fill us with confidence.”

Invesco Perpetual equity manager Neil Woodford sees little hope. He told parliament last year: “There is not enough engagement. Institutional shareholders do not take enough of an interest in the strategic direction of a business.”

He added: “Corralling investors is a bit like herding cats. It is very difficult to get investors even to agree to meet on a particular subject, even if it is particularly egregious.”

Guy Jubb, global head of governance and stewardship at Standard Life Investments, said: “Despite being part of daily parlance, stewardship still struggles to secure its place at the heart of relationships.”

Alastair Mundy, the contrarian equity manager at Investec Asset Management, told Financial News before the publication of the Kay Review: “Investors definitely seem to me to be more short term than ever.”

He is currently far from convinced the situation will change. He said: “I don’t think the Kay report will change human behaviour and the current trend to be obsessed by noise. As long as short-term performance is published it will be over-analysed.”

Hugh Sergeant, head of UK equities at River & Mercantile, is unconvinced Kay has made much impact on his behaviour. That said, he pointed out that holding periods for shares have risen, as a result of markets becoming less liquid after the credit crisis.

Greg Davies, head of behavioural finance at Barclays’ wealth division, said short-term decisions are still producing the kind of snap judgements that led to the credit crisis: “It’s not actually a lack of liquidity that forces people into selling at the bottom, but the fact they’ve run out of emotional liquidity.”

Resistance

The chief investment officer at a large UK pension scheme encapsulates the industry’s resistance to change: “It is really, really hard to know what is going to be profitable over 10-year periods. It is even harder to make capital markets more efficient by writing 100-page reports, but it does make the author, his advisory board and the politicians who commissioned it look good.”

Sarah Wilson, chief executive of proxy research firm Manifest, agreed vested interests are trying to slow up reform. But she added: “Kay was more about nudging behaviour – possibly he was more cerebral than previous codifiers.”

She noted that governance officers and asset managers are working together more closely. Soon after his arrival at Old Mutual Global Investors, for example, Richard Buxton hired his governance associate at Schroders, Paul Emerton.

There is no shortage of evidence that investors who take a simple, long-term approach to investing can outperform. Ten years ago, consultant Towers Watson started recommending long-term mandates to its clients. The approach ensured clients would only sack managers in the event of dire news – such as a mass defection of key staff. In discussing the structure of mandates, it asks its managers to take a long-term approach, turning over no more than a fifth of their portfolios in a year.

Over the past nine years, annualised returns have beaten the MSCI All Country index by 2.5 percentage points a year. Craig Baker, head of research at Towers Watson, said: “We’ve found the results encouraging and a number of our clients have started to use it.”

Warren Buffett, the iconic US investor, Invesco Perpetual’s Woodford, and Singapore-based Hugh Young, head of global equities at Aberdeen Asset Management, have outperformed for decades, thanks to their long-term value-based approach to investment and governance.

Marathon Asset Management, which also takes a long-term approach, has beaten the MSCI World index by 4.2 percentage points a year since the inception of its global product in 1986.

The Orkney Council pension scheme has easily beaten its benchmark, by retaining Baillie Gifford, a
manager that is highly rated by consultants, over the long term. Over five years, the scheme has beaten its benchmark by an annualised 3.4 percentage points.

Regulatory threat

But market participants that are not persuaded by improved performance, or do not respond to pressure voluntarily, could have their hands forced, if the Law Commission decides that changes in legal frameworks are needed. It will release its review of laws
relating to fiduciary management in June, which could dictate that market participants take more responsibility for their actions.

The commission has asked for views on whether the law should be changed to make it easier for trustees to justify making decisions based on sustainable grounds. The Cowan v Scargill legal case has encouraged some lawyers to recommend that scheme trustees should solely base their decisions on investment grounds.

Another suggestion from the commission is that generic advice from consultants be regulated as they also implement investment decisions as fiduciary managers. Certain consultants, such as Mercer, oppose the idea while Towers Watson supports it.

Two years ago, Kay warned delegates at the National Association of Pension Funds’ investment conference that intermediaries were used too often: “This proliferation… carries a cost, in terms of fees, that threatens to run away with a large part of
the returns that savers want.”

Wilson at Manifest believes investors are becoming more interested in sustainable issues but agrees that change will take time, partly as a result of poor-quality reporting. She said: “You get great reports from the likes of Marks & Spencer and Unilever but they are exceptional for being exceptional.” She is working with Ken Olisa, chairman of investment boutique Restoration Partners, to establish global guidelines that will pull together governance, remuneration and sustainable issues to produce a code of conduct.

Further afield, European internal market and services commissioner Michel Barnier, unveiled a European Long-Term Investment Fund, which would encourage people to invest in sectors such as infrastructure for 10 years or more. He said: “Financing is often scarce and, where it exists, too focused on short-term goals.”

In Japan, executives enjoy tenures of office that are long term, but their governance is poor. The country’s regulator, the Financial Services Agency, last year devised a stewardship code, which is designed to improve standards of corporate governance in the belief this will help to encourage investors to buy equities, rather than bonds and cash.

Many firms have tried – and failed – over the years to improve shareholder governance of the companies in which they invest.

Thirty years ago, US corporate governance campaigner Robert Monks started a campaign to encourage responsible ownership. Even then, noting escalating boardroom remuneration, he said: “As I assess things in the US today, the governance movement has made very little progress.”

Ten years ago, a group of pension schemes set up the Marathon Club,
designed to stimulate long-term thinking. It donated £38,000 to the UN’s Principles for Responsible Investment, but the Marathon Club has now been wound up. The PRI is continuing to lobby investors to behave responsibly, recently extending its sphere of influence to the bond market. The European Parliament is set to vote to improve corporate transparency next month.